Everything you ever wanted to know about Microsoft VHD performance
Microsoft recently released a white paper covering everything you ever wanted to know about virtual hard disk performance. The paper compares VHD performance on Windows Server 2008 and Windows Server 2008 R2. It uses the new Native VHD implementation for R2 and loopback VHD 2008. Some of the results are not surprising, but there is a good amount of data to back up recommendations.
Dynamically expanding VHDs are not recommended for virtual machines that run server workloads in a production environment. Fixed VHD is preferred considering it has better performance with committed space allocation so it will not run out of physical backing storage. The following graphs show, in Windows Server 2008 R2, the gap between a fixed VHD and a fully populated dynamic or differencing VHD is fairly small. The major performance gap comes from small I/O writes. However, that gap may be widened if the VHD has to expand itself first before taking any user data.